Rethink your bond strategy for retirement

Time to re-evaluate definition of fixed income

The pundits would have us believe that the bull market in bonds is over. That bond prices have nowhere to go but down and yields up.

Case in point: Berkshire Hathaway
BRK.A, -0.35%BRK.B, -0.08%
Chairman and Chief Executive Warren Buffett told CNBC this week that bonds are “a terrible investment” right now. And Loomis Sayles’ Dan Fuss earlier this year said the fixed-income market is more “overbought” than at any time in his 55-year career.

Overbought and terrible investments as bonds might be, the market doesn’t seem as convinced. Consider, for instance, the yields on Treasury Inflation Protected Securities, also known as TIPS. Those that mature in five years yield -1.28% while those that mature in 10 years yield -0.48%. See Daily Treasury Real Yield Curve Rates.

In other words, bonds might not be the best investment, but the looming bond losses predicted by Fuss, Buffett and others might be a long way off. If that’s the case, what should those planning for or living in retirement do with the money they’ve allocated to fixed-income securities?

And, what if Buffett, Fuss, and others are right in their assessment, that bonds are a terrible investment? What then? Buy, sell, hold or hide your head in the sand? What’s a retiree or retirement saver to do?

In the main, advisers we interviewed agreed with Buffett and Fuss. They say the great bull market in bonds is over, though it might be a while before the bear market begins. Call it a holding pattern with the best bet being avoid or sell long-term bonds.

For instance, William Suplee IV, president of Structured Asset Management, says there are few reasons to own long-term bonds, or TIPS for that matter. “Bonds have run the full cycle from 1950 to 1982 and back till today,” said Suplee. “There is almost nothing left in the long end with one big exception.”

And that exception is this: Should there be a Japanese-style long-term deflationary spiral then long bonds are still a good investment. “But that’s only under that type of scenario and it doesn’t look that probable,” Suplee said.

As for TIPS, Suplee said those investments are “fully priced” and the only reason to hold them now is as an inflation hedge. “If we have big inflation they will help, but not as much as you would wish because of the pricing,” he said. “The real yield will be below inflation.”

Another manger is of the same opinion. “We wouldn’t touch TIPS at these prices,” said Christopher Pavese, the chief investment officer at Broyhill Asset Management.

In the event of hyperinflation, however, Suplee said TIPS will be like gold as a store of purchasing power except for the fact that they have poor tax consequences. “TIPS are taxable and don’t throw off cash flow,” he said. “Ouch?”

(TIPS, for those for whom such instruments are a prudent investment, are best owned in qualified accounts, he said.)

But no matter whether you own TIPS in a taxable or tax-deferred account, Suplee said, the day is dawning when it will be time to get out of them. “Keep durations short,” he said, noting that TIPS, though there’s no associated cash flows, do have an inflation adjustment and tend to have longer durations in some circumstances.

Others agree that it’s time to avoid or dump long bonds. “If the bull market in bonds isn’t over, then you have to ask yourself if you feel lucky, or if you want to become a trader, because the risk level is too high to justify a ‘buy-and-hold’ approach,” said Michael Falk, a partner with Focus Consulting Group and chief strategist at Mauka Capital.

To the extent you cannot spend less in retirement, retire later or work some, his advice to retirees and would-be retirees would be to shorten the maturities of the bonds or bond funds in your portfolio. Consider also adding to the mix a type of annuity that provides a monthly income when you’re age 80+. “The annuity would help to protect against outliving your slower-growth/less-income producing portfolio,” Falk said.

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